Via Nomura's Bob Janjuah,
The titles of my last two notes pretty much speak for themselves. Since May and in particular since my July note my expectations for fundamentals (weak global growth, deep China concerns, “FX wars”, disinflation/deflation outweighing inflation) and my outlook for markets (risk-off, volatility higher) have largely been borne out. China did indeed ”devalue” (I think this is only the beginning), the Fed indeed passed in its September meeting, and my major market targets (that the S&P 500 would fall from the 2100 area to the low 1900s/1800s by end Q3/early Q4, with 10yr UST yields falling from the 2.4% area to below 2%) were met easily in late August. Since then markets have meandered around largely sideways as policymakers attempt to talk things up in the face of intense market concerns. Significant damage has yet again been done to the credibility of policymakers, and to the belief in normalisation, in inflation, and in the ability of risk markets to continue ignoring the harsh realities of weak growth, weak pricing power and weakening earnings.
My bottom line is clear. I believe there is more weakness ahead – both fundamentally and within markets – over Q4 and perhaps into Q1 2016. Of course, there will be counter-trend moves and occasional data bright spots ahead. In particular, I expect more commentary from the ECB, more action from the BOJ and PBoC (markets are looking for effective game-changing moves in fiscal and monetary policy, but I believe China’s devaluations are not over yet), and certainly by/in Q1 2016 I expect markets to be focused on/looking for/dealing with a much more dovish, perhaps even easing, Fed versus the current situation. I repeat my view that the Fed does not need to hike based on fundamentals, but I would not be at all surprised to see the Fed hike in late 2015, in an attempt to convince markets that strong growth and inflation are on their way back. Any such hiking cycle by the Fed would I believe be extremely short-lived and quickly give way to renewed dovishness.
In terms of targets for Q4 I am targeting an 1820 print on the S&P 500, and I fear that we could even see prints in the low 1700s which would entail a 20% move (an official bear market) in the S&P 500 from its 2015 high of 2134. Globally I expect things to be even weaker, particularly (but not exclusively) in the EM space and in global credit markets, which already feel very vulnerable albeit they are attempting to hold onto a sense of orderliness. In terms of core government bond yields, I am looking for 10yr UST yields to again trade below 2%, this time targeting 1.8%. As China reduces its selling of USTs and other core government bonds – which I feel has been done since the devaluation in an attempt to counter the natural capital outflows that are now evident in China – and as China resumes its next leg of FX wars I fully expect core government bond yields to rally strongly.
In light of my May and July targets being hit I have reviewed my two stop-loss triggers. For yields, I retain my previous stop-loss – a weekly closing 10yr UST yield above 2.4% would force me to stop-out and reassess. For risk I am amending my S&P 500 stop-loss trigger a little – a weekly close above 2020 (was 2135) would now stop me out and force me to reassess. I stress that I am expressing views covering Q4 as a whole, and as such I fully expect counter-trend moves within Q4, sparked most likely by DM policymakers. But overall I feel that, much like the second half of Q2 and all of Q3, the overall outlook for Q4 will be for risk-off, higher volatility, heightened growth/earnings/deflation concerns, lower core government bond yields and a continuation of FX wars. And my stop-loss points will provide a prudent degree of protection should my outlook for Q4 prove too bearish.
Priced for recession?
To answer the question, first I should be clear that while I think a US recession is merely possible rather than probable, the evidence is growing in my view that a global recession is more probable than possible. Certainly the global trade data are pointing to meaningful global growth weakness, backed by weak data from EM and large parts of DM too. And a quick look at credit markets, in particular the HY markets in the US and Europe as well as the EM credit space support my view of a global growth recession being probable and not just possible. So if a global growth recession is more probable than possible, then it seems clear to me that neither risk assets nor core rates markets are accurately reflecting this at this time – instead, they reflect the “more possible” scenario rather than “more probable”. In other words, financial markets are NOT yet pricing for a recession, rather they are merely flirting with the idea. I suspect this largely reflects faith/hope in policymakers within market participants. The events of the past few weeks, both going into and after the most recent BOJ and FOMC meetings, should give those heavily invested in policymaker faith/hope a lot of food for thought.
In this context the question I ask myself is, if needed, where is the Fed “put”, and what would such a “put” look like? It is very early in the process and lots will depend on global policy responses and data outcomes, but I am happy to declare my view: the next Fed “put” is not likely until the S&P 500 is trading in the 1500s at least (so more likely to be a Q1 2016 item rather than Q4 2015); and in terms of what the Fed could do, clearly QE4 has to be in the Fed’s toolkit. However, considering the failure of global QE to generate sustainable global growth and inflation, and considering the Fed’s starting point, 2016 could be the year when we see negative Fed Funds as a way of getting money velocity moving up rather than down. Such a move may work, in that risk assets could react very positively for a period of time, but in the longer run any such moves would only serve to highlight the extraordinary ongoing failure by global central banks to manage economies (both into and) since the 2008-09 crash.
Via Nomura's Bob Janjuah,